Defaults in EU: Zero or One?

Action in Europe is becoming interesting. In a sense of Chinese proverb, which, they now say, doesn't exist. The whole bunch of countries has trouble financing budget deficits, most troublesome are Greece and Spain (for now). Half a year ago, Hungary and Latvia had similar problems, but they managed to get loans and can breathe, for now. In the nearest future, we might also witness panic regarding Portugal and Italy. Maybe even UK.

There are two big unknowns in this situation. First unknown: will EU bail out every country nearing default? Or maybe they will decide to play strict parents and let one of the countries default? I an almost sure that there will be maximum one default in EU (one of my non-predictions for 2010). But honestly, even one default will be too much.

Another unknown is even bigger. There are hundreds of billions of dollars in dollar carry trade. Part of those dollars were borrowed to make loans and buy debts denominated in Euro, to play on difference of interest rates and on the idea that dollar is nowhere to go but down (remember, everybody was saying exactly that just three months ago). The biggest question now: at what exchange rate most of carry trade players set their stops? Because if carry trade unwinds, even its part which is related to Euro, it might get ugly.

I'm watching action with mixed feelings. There is a big temptation to buy stock of Greek and Spanish companies, which are selling well below book value now. But in case of default and/or carry trade unwind, they will be selling at huge discount even to current prices. And, in such case, it's a big question which of these companies are going to survive.

For now, I am going just to watch.